Revisiting board independence mandates: Evidence from director reclassifications

Abstract

We provide causal evidence on the effects of mandated board independence. We compare firms that replace existing non-independent directors to firms that retain these directors by reclassifying them as independent. Reclassification eligibility, being largely predetermined, offers quasi-exogenous variation in compliance strategies. We show that firms required to replace insiders perform worse post-mandate, driven by increased operational costs and reduced labor efficiency. Boards of non-reclassifying firms retain fewer former employees and replace them with directors more likely to join monitoring-focused committees, emphasizing the shift from advising to monitoring. Overall, these findings suggest that firm-specific director expertise contributes materially to performance and is consistent with pre-mandate board compositions optimized to balance benefits of enhanced monitoring against costs of reduced advisory capacity. We rule out alternative explanations, including adjustment costs due to director turnover and co-option. Our study underscores the importance of allowing firms’ flexibility in governance structures and cautions against uniform mandates.